When purchasing a home, the interest rate is only one part of the financing decision.
In certain situations, a mortgage buydown can be used to reduce a buyer's mortgage payment — either temporarily during the first few years of homeownership or permanently for the life of the loan.
Buydowns can be particularly valuable when a home seller is willing to contribute money toward the buyer's financing costs.
At Capital Funding Mortgage, we can compare the different options and help determine whether using available funds for a temporary buydown, permanent rate reduction, closing costs, or another strategy provides the greatest benefit.
A mortgage buydown uses money paid at or before closing to reduce the cost of the borrower's mortgage payments.
There are two primary types:
Temporary Buydown
The buyer's principal-and-interest payment is reduced during the first one, two, or three years of the mortgage. After the temporary period ends, the borrower makes the regular payment based on the actual note rate.
Permanent Buydown
Discount points are paid at closing to obtain a lower actual interest rate for the life of the mortgage.
These strategies work very differently, so it is important to compare them before deciding which one makes sense.
A temporary buydown reduces the portion of the mortgage payment the borrower is responsible for during the early years of the loan.
The mortgage itself still has a permanent note rate.
For example, assume the actual mortgage note rate is 6.50%.
A temporary buydown may allow the buyer to make payments during the first several years as though the rate were lower.
The money needed to make up the difference is deposited into a separate buydown account at closing and applied toward the mortgage payments as they become due.
Fannie Mae permits eligible temporary buydowns for up to three years, with the borrower's payment rate generally increasing by no more than one percentage point per year until reaching the note rate. Borrowers are qualified using the actual note rate rather than the temporarily reduced payment.
A 3-2-1 buydown provides the largest initial payment reduction of the commonly used temporary buydown structures.
Using a hypothetical 6.50% note rate:
| Period | Payment Calculated As If Rate Were |
|---|---|
| Year 1 | 3.50% |
| Year 2 | 4.50% |
| Year 3 | 5.50% |
| Year 4 through remainder of loan | 6.50% |
The actual mortgage note rate in this example remains 6.50%.
The buydown account provides the difference between the temporarily reduced payment and the payment required under the mortgage note during the first three years.
A 3-2-1 structure can be attractive for a buyer who would benefit from substantially lower payments during the first few years of homeownership.
The 2-1 buydown is one of the most common temporary buydown structures.
Using the same hypothetical 6.50% note rate:
| Period | Payment Calculated As If Rate Were |
| Year 1 | 4.50% |
| Year 2 | 5.50% |
| Year 3 through remainder of loan | 6.50% |
Freddie Mac describes the same basic structure: with a 2-1 buydown, the borrower's payment is initially calculated two percentage points below the note rate, then one percentage point below the note rate during the second year, before reaching the full note-rate payment.
A 1-0 buydown provides a smaller and shorter payment reduction.
Using a hypothetical 6.50% note rate:
| Period | Payment Calculated As If Rate Were |
| Year 1 | 5.50% |
| Year 2 through remainder of loan | 6.50% |
This option may require a smaller seller contribution than a 2-1 or 3-2-1 buydown while still providing the buyer with some payment relief during the first year.
Depending upon the mortgage program and transaction, temporary buydown funds may potentially be provided by parties such as:
The allowable source and amount depend upon the mortgage program.
When a seller or another interested party funds a Fannie Mae temporary or permanent buydown, the amount is subject to applicable interested-party contribution limits.
VA also permits eligible temporary buydowns and recognizes seller-, builder-, and lender-funded structures, subject to VA requirements.
Because these rules vary by mortgage program, the financing should be reviewed before negotiating the seller credit in the agreement of sale.
Suppose you are purchasing a home and the seller is willing to provide a credit toward your closing costs.
Instead of simply reducing the purchase price, it may sometimes make more financial sense to use some or all of the negotiated seller credit toward a mortgage buydown.
For example, a buyer might negotiate:
Purchase price: $500,000
Seller credit: $10,000
Depending upon the loan program and applicable limits, that $10,000 might potentially be used toward:
Closing costs
A temporary mortgage buydown
Permanent discount points
Or some combination of allowable costs
Which option provides the greatest value depends on the buyer's mortgage, available cash, interest rate, anticipated time in the property, and financial goals.
This is an area where evaluating the numbers before the offer is written can be extremely helpful.
This is one of the most important things buyers need to understand.
In many cases, no.
For Fannie Mae fixed-rate loans with a temporary buydown, the borrower must qualify based upon the actual mortgage note rate rather than the temporarily reduced payment. Freddie Mac similarly requires qualification at the note rate for fixed-rate mortgages with temporary subsidy buydowns.
So a temporary buydown can reduce your initial monthly out-of-pocket payment, but it generally should not be viewed as a way of qualifying for a home you otherwise could not afford.
The borrower needs to be financially prepared for the full mortgage payment once the buydown expires.
A temporary buydown can be particularly attractive when a buyer expects the first few years of homeownership to be more expensive.
New homeowners frequently incur costs for:
Reducing the mortgage payment temporarily can provide additional monthly cash flow during that transition period.
It may also appeal to someone whose income is reasonably expected to increase over time.
However, buyers should make their purchasing decision based upon their ability to handle the full payment, not upon an assumption that they will necessarily be able to refinance later.
A permanent buydown works differently.
Instead of temporarily subsidizing the payment, the borrower or another permitted party pays discount points at closing in exchange for a lower actual mortgage interest rate.
That lower rate remains in effect for the applicable term of the loan.
One mortgage discount point equals 1% of the loan amount.
For example:
$400,000 mortgage
1 point = $4,000
However, one point does not automatically reduce the rate by a specific amount such as 0.25%.
The amount of interest-rate reduction received for a particular number of points varies based upon mortgage-market pricing at that time. The Consumer Financial Protection Bureau specifically notes that discount points have no fixed relationship to a particular rate reduction.
Neither option is automatically better.
A temporary buydown may make sense when:
A permanent rate reduction may make more sense when:
The CFPB notes that paying discount points generally becomes more beneficial when a borrower keeps the mortgage long enough for the cumulative monthly savings to exceed the upfront cost.
Before paying thousands of dollars to permanently reduce an interest rate, we believe buyers should understand the break-even period.
For example, suppose paying discount points costs:
$5,000
and reduces your mortgage payment by:
$100 per month
A simplified break-even calculation would be approximately:
$5,000 ÷ $100 = 50 months
That means it would take a little over four years of monthly savings to recover the upfront cost.
If you expect to sell or refinance before reaching the break-even point, paying those points may not provide the benefit you anticipated.
This is why we prefer to compare the alternatives rather than automatically recommending that a buyer pay points.
This is an important consideration when choosing between a temporary and permanent buydown.
Suppose a seller is offering a sizable credit.
You could potentially use that money to permanently reduce today's interest rate.
But if market rates decline substantially and you refinance relatively soon, you may not have held the original mortgage long enough to recover the money spent on permanent discount points.
A temporary seller-funded buydown may sometimes provide a different strategy: enjoy reduced payments during the early years while retaining the possibility of refinancing if future rates make doing so financially worthwhile.
There is no guarantee that mortgage rates will decline, however, and a buyer should never choose a loan based solely upon an expectation of refinancing later.
The answer depends upon the applicable mortgage program and the written buydown agreement.
For Fannie Mae loans, when the mortgage is paid off before all buydown funds have been used, the remaining funds may be credited toward the amount needed to pay off the mortgage or handled as specified in the applicable buydown agreement.
You should therefore understand the terms of the specific buydown agreement before closing rather than assuming unused funds will simply be refunded to you in cash.
No.
Temporary buydown eligibility varies based upon:
For example, Fannie Mae permits temporary buydowns on eligible principal residences and second homes but does not permit them on investment-property loans. Certain adjustable-rate mortgages also have additional restrictions.
Temporary buydowns are also available with certain government-backed mortgage programs, subject to the requirements of the applicable agency and lender. VA, for example, currently permits qualifying temporary buydowns on fixed-rate VA loans.
Possibly.
This can be especially worth considering when:
A property has been on the market for an extended period.
The seller has already reduced the asking price.
The seller is motivated to close.
The buyer has sufficient funds for the down payment but wants a lower initial payment.
The seller is willing to provide closing-cost assistance.
Rather than simply asking, "Can we get the seller to reduce the price?" it may be useful to ask:
"Would a seller credit toward my mortgage provide me with a greater financial benefit than an equivalent reduction in the purchase price?"
The answer can sometimes be surprising.
A mortgage buydown should not be selected simply because 3-2-1 or 2-1 sounds attractive.
We can compare several structures side by side, including:
No buydown
1-0 temporary buydown
2-1 temporary buydown
3-2-1 temporary buydown
Permanent interest-rate buydown
Applying seller credits toward closing costs instead
Reducing the purchase price
We can show you the estimated upfront cost, monthly payment differences, long-term savings and potential break-even period so you can see which alternative makes the most sense for your particular transaction.
If you are considering purchasing a home and believe the seller may be willing to provide a credit, contact us before your real estate agent prepares the offer whenever possible.
Knowing how much seller assistance is permitted and how that money could be used allows you and your real estate agent to negotiate with a clearer understanding of the financing options.
John Madden
Capital Funding Mortgage
41 University Drive, Suite 400 #475
Newtown, PA 18940
Phone: (855) 580-5626
Email:info@capitalfundingmortgage.com
Website:www.capitalfundingmortgage.com
NMLS #960139
Mortgage programs, rates, discount-point pricing, seller-contribution limits and temporary buydown requirements are subject to applicable investor, agency, lender and underwriting guidelines and may change. Not every borrower, property or loan program will qualify. Examples shown are for educational purposes only and do not represent a current interest-rate quote or commitment to lend.
